The following Is a transcript of the video above.
Let’s Try a Practice Question
In a corporate liquidation, which of the following securities have the highest priority to receive any remaining assets?
- Mezzanine debt
- Common stock
- Senior secured debt
- Preferred stock
The answer here is 3.
Senior secured debt is the most conservative. Let’s talk about the rate of return. So senior lenders have top priority, and they are secured. What does that mean? When we say secured, and we are owed money, what are we allowed to look to? I, the lender, can look to a particular asset, but it is not always guaranteed. When we borrow money on a senior secured basis, we are pledging collateral as a backstop. If we do not repay that money, the lender can come take it.
Is a Personal Mortgage Secured?
Yes, a mortgage is secured. It is secured by your house. Is a credit card loan secured, meaning when you buy things on your credit card, is it secured or unsecured? It is unsecured. If you do not pay the Visa bill, they cannot take the stuff you bought, because it is an unsecured loan. What is the borrowing cost on a credit card? It does vary, but typically it is 18% to29%. That’s the difference between that secured lending or unsecured lending. In this corporate liquidation scenario, what is the lowest priority? Who is last in line? Common stocks.
Last in line here is common stock, while on top is senior secured, debt is the number two, and then preferred stock. Now, let’s say you did not know what mezzanine was in this question. Mezzanine is a term that describes “in the middle.” It is between debt and equity. Even if you did not know what this was, even if this was totally confusing to you, you would have said, well, one is debt and the other is stock, therefore, you can make the decision. There we see how we try and work on these questions even if we’re not sure, by looking at some of the other terminology.